Chapter 5: Section 1 - Section 2.4

Question 1

What are the various elements of the audit risk model?

Answer 1

Inherent risk
Control risk
Detection risk

Question 2

What can the auditor use the various elements of the audit risk model to do?

Answer 2

Understand the risks presented by an audit client

Question 3

What does the auditor use substantive procedures to do?

Answer 3

Test the various items on the statement of financial position

Question 4

When using substantive procedures to test the various items on the statement of financial information, what does the auditor consider and why?

Answer 4

The appropriate assertions for these balances
Help auditors to gather evidence to form a conclusion about each specific item

Question 5

Define non-current assets.

Answer 5

Assets held for continuing use in the business

Question 6

From earlier chapters, what are the relevant assertions for assets and liabilities? (5)

Answer 6

1. Existence
2. Completeness
3. Rights and obligations (or ownership)
4. Valuation
5. Disclosure (or description)

Question 7

Assets are always assets and both debit balances.
True or false?

Answer 7

False - usually both but not always

Question 8

What is the asset balance that is usually the largest for an entity?

Answer 8

Non-current assets

Question 9

What are the 2 main asset areas to look at?

Answer 9

NCA and Inventory

Question 10

What is an important test when reviewing non-current assets?

Answer 10

Ensuring only capital expenditure is included in the SoFP

Question 11

What is the main thing we need to understand around leases (IFRS 16) for this exam?

Answer 11

Do not need detailed knowledge of financial reporting standard Leases (IFRS 16)
Do need to understand key risk associated with this iten, which is that it may be materially misstated in the financial statements.

Question 12

Define lease

Answer 12

A lease is ‘a contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time, in exchange for consideration’ (IFRS 16: Appendix A)

Question 13

What is the underlying leased asset referred to as?

Answer 13

Right-of-use asset

Question 14

What is a lessee?

Answer 14

The entity that has the right to use the leased asset

Question 15

What does IFRS 16 require in relation to recognition of all leases?

Answer 15

Requires recognition of all leases in the lessee’s statement of financial position except short-term leases (those with a lease term of 12 months or less) and leases where the asset is of low value (taken on a case by case basis)

Question 16

In the financial statements of a lessee, what will examples of headings be in relation to the leased asset?

Answer 16

SFP
NCA –> Right-of-use asset
NCL –> Lease liability
CL –> Lease liability
SPL
Depreciation charge (in relevant expense category)
Finance charges

Question 17

What must auditors do with leased items?

Answer 17

Test leased items to verify they are correctly accounted for in line with IFRS 16

Question 18

There are 4 issues which could happen in relation with audit risk for leases.
Name the first 2 related to recognition?

Answer 18

1. Recognition of an asset as a right-of-use asset when it does not qualify (such as short term or low value leases, or any that do not satisfy the criteria from IFRS 16, such control or identification)
2. Non-recognition of a leased asset which should be classified as a right-of-use asset

Question 19

There are 4 issues which could happen in relation with audit risk for leases.
Name the last 2?

Answer 19

3. Material misstatement in the accounting treatment of a right-of-use asset (such as incorrect calculation of any lease assets or liabilities, or the amount to be charged in depreciation)
4. Incorrect classification between current and non-current lease liabilities

Question 20

Define inventory

Answer 20

Sub-classified as raw materials, work in progress (WIP) and finished goods

Question 21

What must the audit approach for inventory include?

Answer 21

The 3 main elements of inventory balances seen in the statement of financial position

Question 22

What are the 3 main elements of inventory balances see in the statement of financial position?

Answer 22

1. Quantity
2. Valuation
3. Disclosure

Question 23

What is the main audit test in relation to inventory?

Answer 23

Attending physical inventory count carried out by the audited entity - provides evidence of inventory quantity.

Question 24

What does attending physical inventory audit test give evidence in relation to?

Answer 24

Completeness, rights and obligations (ie ownership) and existence

Question 25

What other evidence can audit test of attending physical inventory count provide?

Answer 25

Corroborative evidence of the likely valuation of such an asset due to recording information about the condition of inventory as well.

Question 26

Name the 3 methods for an entity to physically count its inventory.

Answer 26

1. Year-end count 2. Interim count 3. Continuous inventory records and perpetual inventory

Question 27

What is the year-end count method for physically counting inventory?

Answer 27

Where entire inventory of the entity is counted as close to the reporting period end as possible to provide a figure for the closing inventory balance

Question 28

What is the interim count method for entity to physically count its inventory?

Answer 28

This is with follow through to year end. This is as the year end count but the count occurs during the year and all items both inwards and outwards are reconciled to arrive at a calculated amount

Question 29

What is the continuous inventory records and perpetual inventory method for an entity to physically count its inventory?

Answer 29

Automated system records all items inwards and outwards, and maintains an ongoing balance of inventory at any one time - is tested periodically as part of the entity's normal controls assessment.

Question 30

It is the auditor's responsibility to count the inventory. True or false?

Answer 30

False The auditor will attend the entity's physical inventory count to verify inventory quantities but it is not the auditors responsibility to count the inventory.

Question 31

What is inventory count carried out as part of?

Answer 31

As part of legal responsibilities of management of entity to keep accounting records in line with the Companies Act 2006

Question 32

What is the mot common method for the auditor to gain evidence as to the amount of inventory held at the end of the reporting period?

Answer 32

To attend the year-end inventory count

Question 33

Once quantity is established by attending the entity's count, what is the next characteristic of inventory that must be assessed?

Answer 33

Valuation

Question 34

What must inventory is valued at?

Answer 34

Lower of cost and net realisable value (NRV)

Question 35

To comply with what IAS must inventory be valued at lower of cost and NRV?

Answer 35

IAS 2 Inventories (para 9)

Question 36

What must the auditor need to do in regards to valuation?

Answer 36

Needs to design procedures that establish amounts for each for this comparison to occur

Question 37

What does the use of accounting estimates require?

Answer 37

Loss requires degree of judgement by entity's management. Auditor needs to establish whether their conclusion is reasonable or not

Question 38

What is an example of a loss when using accounting estimates?

Answer 38

E.g. looking at possible impact on NRV of supermarket inventory of items going literally 'past their shelf life'.

Question 39

What are accounting estimates required for?

Answer 39

Valuing items of raw materials, work in progress (WIP) and finished goods

Question 40

As well as the amounts of inventory included in the FS what else do auditors review?

Answer 40

The way they are presented and disclosed - classification is the appropriate assertion here and auditor will make sure that the relevant disclosure requirements are followed

Question 41

What do typical disclosures in relation to inventory include?

Answer 41

1. Accounting policies used in calculating things such as cost and NRV are fully disclosed 2. Ensuring inventory is sub-classified as raw materials, WIP and finished goods

Question 42

Why are raw materials of inventory tested?

Answer 42

To ensure they are held at cost

Question 43

Why are raw materials tested to ensure they are held at cost?

Answer 43

Because it is extremely unlikely that NRV would differ from cost for raw materials unless they had been damaged or the value was affected by age.

Question 44

In regards to raw materials, what must auditors first understand?

Answer 44

How the company determines the cost of raw materials.

Question 45

If a company is able to identify each item separately when looking at raw materials, what can they be valued at?

Answer 45

Own original cost

Question 46

Why can some inventory not be valued on an individual item basis e.g., each raw material and what will they have to do instead?

Answer 46

Due to the nature of it Company will have to use a technique such as FIFO

Question 47

What do accounting standards define cost as?

Answer 47

Cost of purchase plus cost of conversion

Question 48

When does the cost of conversion become relevant?

Answer 48

When considering WIP and finished goods

Question 49

What will cost of conversion include?

Answer 49

1) Directly attributable costs (e.g., labour, machine costs) 2) Other production costs (e.g., lighting in the factory)

Question 50

What will the auditor need to test in regard to cost of conversion?

Answer 50

The company's calculation of cost of conversion

Question 51

How can the auditor test the company's calculation of cost of conversion in general terms?

Answer 51

May apply analytical procedures (e.g., comparing similar inventory lines from this year to last year to see if any changes in price appear reasonable)

Question 52

What are finished goods most likely to be affected by and why?

Answer 52

NRV as there is a market for them

Question 53

What else can be affected by NRV but is more difficult to judge?

Answer 53

WIP

Question 54

What is NRV?

Answer 54

Estimated or actual selling price of the goods

Question 55

What must auditors ensure happens with any goods noted as being obsolete or damaged at the inventory count?

Answer 55

That they have been reduced in value

Question 56

What is the main aim of the auditor in regards to consistency and the amount of inventory?

Answer 56

Ensure there is consistency over when an amount of inventory is either purchased or sold.

Question 57

Why is the main aim of the auditor to ensure consistency over when an amount of inventory is either purchased or sold?

Answer 57

Must ensure this given the sensitivity of the SPL items like 'profit' and 'cost of sales' to recorded amounts of inventory

Question 58

What concept is aimed to be applied to invenotry when looking at the auditors main aim?

Answer 58

To apply the matching concept especially at the very start and end of the reporting period to ensure inclusion in the correct year

Question 59

What is the rule in regard to recording income and expense?

Answer 59

Income and expense is recorded at the point where the risks and rewards of ownership are transferred (ie based on movement of inventory).

Question 60

What note relates to items of revenue?

Answer 60

Goods Despatched Note (GDN)

Question 61

What note relates to items of purchases ?

Answer 61

Goods Received Noted (GRN)

Question 62

What is the ruling in regards to goods despatched before year end and after year end in relation to inventory cut off?

Answer 62

Before YE - Include revenue and receivables. Do not include inventory After YE - Include inventory. Do not include revenue and receivables

Question 63

What is the ruling in regard to goods received before and after year end in relation to inventory cut off?

Answer 63

Before YE - Include purchases, payables and inventory After YE - Do not include purchases, payables and inventory

Question 64

What is the cut off test for revenue?

Answer 64

a) Obtain last GDN number at year end b) Select a sample of GDNs raised before and after YE and ensure revenue is accounted for in the correct period. Select a sample of sales invoices posted before and after the year end and ensure that GDNs are raised in the purchase invoice

Question 65

What is the cut off tests for purchases?

Answer 65

As for revenues, but replace GDN with GRN and sales invoice with purchase invoice.

Question 66

What are trade receivables?

Answer 66

Amount owed by customers in respect of credit sales

Question 67

What is circularisation?

Answer 67

Specific technique used to test the receivables balance by writing directly to customers owing money to the audited entity and asking them to confirm what they believe they owe

Question 68

What can circularisation results be used for?

Answer 68

To compare against records held by the entity of sums owed by that customer and any discrepancies reconciled.

Question 69

[Not sure if needed for exam] What are the steps to conduct circularisation?

Answer 69

1. Obtain listing of YE trade receivables 2. Agree total to SLCA in nominal ledger 3. Review listing for obvious omissions or misstatements 4. Select sample of receivables accounts for positive confirmation - letter should be on client's headed note paper, signed by client with copy of current statement attached. Should request reply is sent directly to auditor and reply-paid envelopes should be included 5. After reasonable period, auditor should send follow-up requests by post 6. If responses still not forthcoming, should be followed up by emails and phone calls 7. Auditor should investigate any disputed balances 8. Often 50% resonse rate is best auditor can hope ofr but all reasonable efforts should be made to agree receivables sampled where no reply - achieved by confirmation of individual outstanding invoive or alternative procedure e.g., verifying outstnading items to back up documentation.

Question 70

What is the downside of circularisation?

Answer 70

Usually only a good test of existence and rights and obligation - does not test valuations as most customers will not confirm if balance is understated and agreeing that a debt is owed does not provide evidence the debt will be settled.

Question 71

What does cash and bank include?

Answer 71

Includes all bank accounts held by the entity as well as any cash amounts held on site (such as petty cash and till floats(cash at start of day))

Question 72

What is the key audit test performed in the area of cash and bank?

Answer 72

A review of the audited entity's bank reconciliation

Question 73

What is a bank reconciliation?

Answer 73

Process designed to understand the timing differences between the entity's cash book and the bank's understanding of the entity's bank balance

Question 74

What is practice note 16 about?

Answer 74

Bank report for audit purposes

Question 75

What is practice note 16 specifically about?

Answer 75

Practice of sets out how both sides should act in the regard of getting hold of information from third party

Question 76

Why is the practice note 16 needed?

Answer 76

Practice of obtaining certificates or reports from banks is an important feature in the proper discharge of the auditor's responsibilities but difficult for the auditor is getting hold of info regarding their client from a third party with whom they have no direct contractual relationship.

Question 77

What are the procedures in relation to practice note 16?

Answer 77

1) Standard letter should sent in duplicate on each occasion by the auditor on their own note paper to each bank branch the client holds an account at or has had dealings with since the end of the previous accounting period 2) Auditors should ensure the bank receives their client's authority to permit disclosure of such information to a third party

Question 78

For practice note 16, what is the core information/contents in the standard letter?

Answer 78

a) Bank accounts and balances (inc details of any restrictions on accounts for balances and details of accounts closed during the period) b) Details of set-off arrangements c) Loans, overdrafts and associated covenants, guarantees and indemnities, inc term and repayment frequency d) Securities charged with reference to items listed above e) Other banks or branches where the customer has established a relationship during the period

Question 79

What is the supplementary info requested in the bank letter?

Answer 79

a) Trade finance: bills discounted with recourse, any guarantees, bonds or indemnities given to the bank by the customer on behalf of third parties and other contingent liabilities b) Securities (Practice Note 16, Appendix 1)